Why is the Netherlands doing so badly?

16/6/2016

By Matthew C Klein

Some might blame the weak growth figures on the failure of many European governments, particularly France and Italy, to sufficiently embrace “reform”, whatever that means. (We’ve also been told Greek governance leaves something to be desired, especially by people who think the debate over the true size of the debt misses the point.)

While we happily admit better institutions can make countries richer and improve their resilience to the vicissitudes of the business cycle, this explanation fails to convince.

Consider the Netherlands.

By any Teutonic measure of “competitiveness”, the Netherlands is a standout performer. It has the biggest current account surplus, as a share of output, in the entire euro area, making Germany look almost Anglo-Saxon by comparison. The Netherlands is ranked the 5th “most competitive” economy in the world according to the World Economic Forum (the same folks who have that event in Davos), effectively tied with Germany. By comparison, France is ranked 22nd, Spain is 33rd, Portugal is ranked 38th, and Italy is ranked 43rd.

Yet the employment rate for Dutch 25-54-year-olds, a reasonable measure of the economy’s underlying vigour, is still about 5 percentage points below the pre-crisis peak. That’s basically the same situation as in Italy (note the different y-axes, which we used because the starting levels are different):

The chart below compares changes, in percentage points, in the share of people aged 25-54 with a job in the Netherlands against the changes in euro area countries that at one point or another were considered to be in the “periphery”:

From this perspective, the Netherlands has done about the same as Italy, a bit worse than Spain, and quite a bit better than Greece. (Note the numbers for Ireland, and to a lesser extent, Portugal and Spain, may be slightly misleading because of mass emigration.)

Real household consumption per person is probably the single best proxy of living standards. The Dutch are still consuming about 5 per cent less, on average, than they were almost a decade ago. That’s slightly better than Italy but significantly worse than France and Portugal:

What can explain this? If the problem can’t be blamed on an “uncompetitive” economy suddenly forced to reckon with a reversal of capital flows, something else has to be to blame.

An interesting comparison, which we’ve looked at before, is Belgium. Unlike the Netherlands, but very much like an unhealthy combination of Greece, Italy, and Spain, Belgium entered the crisis with high government indebtedness, ultra-expensive labour costs, a worsening external position, a massive increase in house prices, and a dysfunctional political system. During the crisis, Belgian sovereign spreads widened sharply. Yet Belgium escaped unscathed, while the Netherlands has suffered:

We’d identified several reasons Belgium did so much better than the other members of the “periphery” in our earlier post. Some — tight economic integration with the German export machine and a massive net foreign asset position — also apply to the Netherlands, so they can’t be sufficient to explain the disappointing Dutch data.

That leaves two other potential differences.

Belgium had somewhat looser fiscal policy than its neighbours, thanks in part to the absence of an elected government with the legitimacy to do anything. Excluding interest payments, Belgium’s budget deficit has only shrunk by about 1.5 percentage points of GDP since the peak in 2009, whilst the Dutch government balance has tightened about 3.5 percentage points. The Netherlands probably would have benefited from looser policy but this difference alone seems too small to explain the massive difference in performance.

Then there’s the housing market. Both countries experienced large increases in house prices before 2008, but only the Netherlands experienced a sustained bust:

From the peak in mid-2008 until the trough at the end of 2013, Dutch house prices fell by 21 per cent. They’ve been recovering slowly since then, along with employment, but are still about 15 per cent below peak. By contrast, Belgian house prices continue to breach new highs.

As we discussed in our post on Belgium, its boom occurred from a low base and wasn’t fueled by excessive borrowing. Unusually, Belgian loan-to-value ratios were falling even as prices soared, while household debt remained tiny relative to income.

The Dutch, however, are the most indebted households in the euro area, in part because of tax benefits for leverage. Residential mortgage debt outstanding was worth twice the total disposable income earned by households at the end of 2015. Fittingly for a country where much of the population lives below sea level, about 30 per cent of Dutch homeowners have negative equity.

Past profligacy made the Dutch economy highly vulnerable to a reversal of fortune. Making matters worse, the Dutch legal system provides limited options for debt restructuring. (That’s a big difference from America’s system.) From box 2.4.1. of the latest European Commission report on the country’s macroeconomic imbalances, emphasis ours:

''According to Statistics Netherlands, 1.5 million households held negative housing equity in 2014. Despite this still high number, the consumer insolvency procedure is not so attractive for holders of negative housing equity, because debt discharge may not be granted…An important feature of the consumer insolvency procedure is that the outcome of a debt restructuring or bankruptcy does not necessarily entail a debt discharge. The Wsnp [acronym for Dutch name of bankruptcy law] establishes an elaborate settlement procedure. Applications are only admissible if previous out-of-court negotiations have failed.

When Wsnp debt restructuring is launched, a period of good conduct is imposed, generally three years, but possibly up to five years. During this period the debtor has to work and is granted an income comparable to the minimum wage by the rescheduling administrator. Other earnings and any income from foreclosed property flow into debt repayment. The administrator directly receives and checks all of the debtor’s mail during the first 13 months of the period of good conduct.''

This draconian regime encourages Dutch households to slash consumption and prioritise debt repayment, a prescription that may sound familiar in the context of the euro crisis. In the Dutch case, the household savings rate rocketed up from around 5-6 per cent of disposable income to about 9 per cent:

So what does all this tell us?

The Dutch economy began to recover around the end of 2013. Employment started picking up, house prices bottomed, and even real household consumption began to show signs of life. The same patterns can be seen in the Italian data. The question is why. Whatever the explanation, it likely tells us much more about the euro area’s weakness than any diatribe about the need for “structural reforms”.

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